Let’s summarize. Bernanke says that the economy is utter crap. The market interprets these comments to mean the Fed will cut rates. The net result is a market rally. So what can we learn from this episode? Investors only care about one thing: the direction of interest rates.

Therefore, I propose a new Fed Model. From now on, the Fed should cut 25bps at every meeting. Forever. Once this strategy has been announced, and investors can bank on continuous interest rate cuts, the markets will absolutely rip. In fact, the Fed can simultaneously solve the US debt problem by buying S&P futures before its announcement. Last time I checked, there’s no law against the government itself inside trading.*

once the discount date rate goes negative, banks would be able to make money borrowing at the Fed Window. There would then be infinite demand for securities for banks to use as collateral at the discount window which would drive the APCP yields to zero which would proably mean SIVs would come back, which would mean a re-birth of the CDO markets and my friends at Citi wouldn’t have to get fired next week. At least I think that’s how it would work. It’s important to think these things through.

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